Business context and reporting period
The Gap, Inc. is a global apparel retailer operating Gap, Old Navy, Banana Republic, Athleta, Intermix, and Weddington Way through stores, online channels, and franchisees. The supplied filing is a Form 10-Q for the quarter ended October 28, 2017 (13 weeks) and year-to-date 39 weeks ended October 28, 2017. This conflicts with the request metadata of “2016 Q3”; the filing itself reports fiscal 2017 Q3.
Financial performance
| Metric | Q3 2017 | Q3 2016 | 39 weeks 2017 | 39 weeks 2016 |
|---|---|---|---|---|
| Net sales | $3.838bn | $3.798bn | $11.077bn | $11.087bn |
| Gross profit / margin | $1.525bn / 39.7% | $1.493bn / 39.3% | $4.307bn / 38.9% | $4.139bn / 37.3% |
| Operating income / margin | $378m / 9.8% | $389m / 10.2% | $1.083bn / 9.8% | $890m / 8.0% |
| Net income | $229m | $204m | $643m | $456m |
| Diluted EPS | $0.58 | $0.51 | $1.62 | $1.14 |
| Operating cash flow | Not reported separately | Not reported separately | $600m | $800m |
| Capital expenditures | Not reported separately | Not reported separately | $463m | $383m |
| Free cash flow (company-defined, non-GAAP) | Not reported separately | Not reported separately | $197m | $417m |
- Q3 comparable sales increased 3%, versus a 3% decline a year earlier. For the first 39 weeks, comparable sales rose 2%, versus a 3% decline.
- Q3 sales growth was led by Old Navy; Gap and Banana Republic sales declined. Year-to-date sales were nearly flat, with a $49m unfavorable foreign-exchange impact.
- Cash and cash equivalents were $1.353bn at October 28, 2017, down from $1.522bn a year earlier. Current assets were $4.483bn and current liabilities $2.596bn.
- Debt totaled $1.248bn, consisting primarily of 5.95% notes due April 2021. The $500m revolving facility had no borrowings; the Japan term loan was repaid in June 2017.
- Q3 declared and paid dividends were $0.23 per share; year-to-date dividends were $0.69 per share.
Material changes versus the prior comparable period
- Q3 revenue increased 1%, net income rose $25m, and diluted EPS increased $0.07. Gross margin improved 0.4 percentage points, while operating margin declined 0.4 points as operating expenses rose.
- Year-to-date revenue was down $10m, but operating income increased $193m and net income increased $187m. Comparisons benefited from $179m of restructuring costs in the prior-year period and a $64m Fishkill fire insurance gain in 2017.
- Year-to-date operating cash flow fell $200m and free cash flow fell $220m. Management cited working-capital timing, including inventory and accounts payable, among the drivers.
- The company repurchased 12.5m shares for $300m year to date; no repurchases occurred in the prior-year period. Cash dividends paid were $272m versus $275m.
- Year-to-date store asset impairment charges were $17m, compared with $89m in the prior-year period. Company-operated store count declined to 3,193 from 3,281 a year earlier.
Outlook, commentary, risks, and unusual items
- Management said existing cash and operating cash flows should support operations, growth initiatives, and planned capital expenditures for the next 12 months and beyond; the revolving facility or other market instruments could supplement liquidity if needed.
- The company intended to pay a fiscal 2017 annual dividend of $0.92 per share, consistent with fiscal 2016. No specific revenue or earnings guidance was provided in the supplied filing.
- Management prioritized on-trend products, digital and customer capabilities, customer experience, talent, and operating efficiency. It expected foreign-currency depreciation to continue pressuring foreign subsidiary gross margins, net of hedging.
- The Fishkill distribution-center fire continued to create logistics costs. In Q3, $20m of business-interruption insurance proceeds reduced cost of goods sold; year to date, the company recorded a $64m insurance gain in operating expenses and received $131m of insurance proceeds.
- Key disclosed risks include changing apparel and channel preferences, competition, inventory and margin management, foreign exchange, global sourcing, cybersecurity, consumer spending, and execution of digital and IT investments. Litigation and claims were not considered material in aggregate, though outcomes remain uncertain.
- Upcoming accounting changes: revenue-recognition adoption was planned for fiscal 2018 and was not expected to materially affect the statements, though recognition timing and balance-sheet presentation would change. Lease accounting adoption was planned for fiscal 2019 and expected to substantially increase reported assets and liabilities.
Important facts for investors to verify
- Confirm the intended reporting period: the request says 2016 Q3, but the filing covers Q3 fiscal 2017.
- Assess whether comparable-sales gains, particularly at Old Navy, are sustainable and whether Gap and Banana Republic can improve.
- Separate recurring operating performance from the $64m Fishkill insurance gain and compare results with prior-year restructuring charges.
- Track working capital, capital spending, and cash conversion given the decline in operating and free cash flow.
- Verify progress on Fishkill insurance recoveries and rebuilding costs, foreign-currency exposure, and the planned dividend and repurchase program.